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Rights Issue

Rights Issues are Corporate Actions Events whereby a company seeks to increase its capital by issuing new securities.

Existing shareholders need to be given a chance to maintain their stake in the company to prevent dilution.

So, rights are credited to existing shareholders of a company.

Cross-ex trades result in claims and compensations.

The rights are securities just like shares and can be listed on a stock exchange.

Rights themselves are often tradable during a predetermined trading period.

Rights can be exercised to subscribe to new securities during the exercise period.

On the paydate of the event, the shareholder who exercised the rights will receive the resulting securities and will pay the company the exercise price per share.

Rights that were not exercised will lapse

Glossary for RightsIssues:

Announcement date

The date at which the company announces the event officially

Exdate

The date at which the parent line shares trade without the entitlement to the rights. For example if the rights issue has an exdate of 24.03.2009 this will mean that all shares traded up until 23.03.2009 will entitle the buyer or the holder of the shares to the rights.

Record date

Date at which holdings are being taken in order to calculate entitlements.

Deposit date

Date at which the rights have to be settled in the account of a direct market participant or agent bank.

Exercise period

The period during the event in which instructions can be sent to the broker/custodians/agents to exercise the rights in order to subscribe to new shares.

Trading period

Rights are securities that can be listed (for short periods of time) at a stock exchange themselves just like other securities. This period of time can

Nil paid rights

Rights can be nil paid or fully paid. When credited to the shareholders rights are nil paid, meaning that no payment has been made to exercise the right.

Fully paid rights

Rights can be nil paid fully paid. If the holder of the rights who exercised them pays the exercise price, the rights become fully paid.

Ratios

There are 2 ratios in the event of a rights issue: the amount of rights one is entitled to per original parent line share one held and the amount of rights one needs to exercise in order to be able to subscribe to one new resultant security. For example: One share entitles to receive one right (1 old : 1 old) and 5 rights entitle to subscribe to 2 new shares (5 old : 2 new).

Parent line shares

The actual shares of the company that cary the entitlement to the rights.

Resultant line security

The resultant line shares are the security that holders of the rights can subscribe to by exercising the rights in the rights issue. These can generally be equity, bonds or convertible bonds.

Young shares

When the event of a rights issue takes place during course of the dividend year, the company can decide to credit holders who exercised their rights Young Shares rather than the final resultant line shares. Young shares are credited under a different (temporary) ISIN and will assimilate back into the parent line after the next due dividend has been paid on the parent line shares.

Oversubscription

Shareholders can be entitled to subscribe to more shares than they'd normally be entitled to if they'd exercised their full amount of rights. This option is not always offered.

Options

The options that shareholders have during the event of a rights issue are to 1) Exercise the rights, 2) Oversubscribe to new securities, 3) buy additional rights, 4) sell their rights, 5) Lapse their rights or 6) Take No Action. In theory, every beneficiary owner of the rights will have to send an official instruction to their broker or custodian on what they decide to do with their rights.

In the money

If the exercise price is lower than the market price of the shares the rights issue is called "in the money". It is attractive to subscribe to the new securities, because they can be sold in the market for a higher price

Out of the money

The compay can set the exercise price too high. In that case it would be unattractive for the investor to subscribe to the new securities in the event. The same shares could be bought in the market for a lower price

At the money

When the exercise price is exactly the same as the price of the securities in the market, the event is called "at the money".

Exercise

The hoder of the rights decideds to send an instruction to their broker or custodian to exercise the rights in order to buy the new securities.

Oversubscribe

The holder of the rights has the right to subscribe to more shares than they would be entitled to by just exercising the rights. Oversubscription is often subject to scaleback (in case too many shares are being subscribed to). Oversubscription is not always possible in every rights issue.

Buy

Basically anybody can buy rigths if the rights are tradeable (even if they didn't hold the shares on the exdate and the record date of the rights issue event.

Sell

The holder of the rights decides to send an instruction to their broker or custodian to sell their rights.

Lapse

The holder of the rights decides to send an instruction to their broker to let the rights lapse at the end of the exercise period. This is very similar to taking no action.

Noac

The holder of the rights decides to send an instruction to their broker to leave the rights in the account and do nothing with them. Often investors hold accounts with other brokers or custodians and it could be that they decide to transfer or sell the rights via another broker or custodian.

Market deadline

This is the official daedline set by the agent of the event by which all instruction need to be received.

Custodian deadline

This is the deadline that the custodians set for their clients.

Broker deadline

This is the deadlien that the brokers set for their clients

Claims

Due to the difference in trade date and settlement date of the shares into accounts when trading. Shares that are traded and settled over the exdate of a rights issue need to be compensated. For example: If a settlement cycle is t+3, meaing all trades are settled in accounts 3 days after trade date (T) and if trader A sells 100 shares to trader B on 23.03.2009 and the exdate of a rights issue is 24.03.2009 this will mean that the trades will be still in the account of the custodian of trader A on the 24.03.2009 (since the will only settle into the custodian's account of trader B on 26.03.2009. When the paying agent credits the rights to shareholders on exdate (without a T+x settlement cycle), the rights in this case will be credited to trader A. But since trader B bought the shares before the exdate, he is entitled to the rights. Trader B has to claim the rights from trader A. This process is also being referred to as compensation.

Click here to find out more about CLAIMS

CUM / EX

Shares are traded WITH entitlement to the rights until the EX date, which is the day the shares are traded WITHOUT entitlement to the rights.

Exercise price

This is the price that needs to be paid for the new securities that result from the rights issue event. This price usually is offered at a discount to the current market price.

Bookbuilding

A method by which the exercise price is being determined by calculating the volume weighted average price of the shares during a predetermined period of time.

Paydate

There are two paydates in a rights issue; cash pay date and stock pay date. Both can be on the same day but they can also differ (usually depending on market). The cash pay date is the date at which the subscription price needs to be paid to the agent. The stock paydate is the date at which the resultant shares will be dispatched.

Paying agent

The party in the market working on behalf of the company that takes care of the technical process of the whole rights issue event (including notifications, instructions managment, collecting the money and issuing the new shares.

Underwriters

Underwriters and the company that wants to increase its capital can sign official legal contracts called purchase agreements. In the purchase agreements, the underwriters commit themselves to buy all the shares at the exercise price that other shareholders did not subscribe to. In that way a succesfull capital increase is guaranteed for the company. The company will have to pay the underwriters a fee for taking over the risk.

Lapsing rights

When the rights issue event is over, the agent will lapse the rights. Depending on the market and the situation, the rights can be lapsed worthless or agains money. In case they are being lapsed worthless, they will just be booked out of the accounts worthless. Sometimes, the leadagent tries to find buyers for the additional rights and in that case the rights will lapse versus money.

OPTIONS FOR INVESTORS IN A RIGHTS ISSUE:

EXERCISE

Rights can be exercised to subscribe to new shares

OVERSUBSCRIBE

In theory every shareholder can subscribe to an amount of shares that is equivalent to their present stake in the company. In some rights issues it is possible to subscribe to more newly issued shares. In case there are more shares being oversubscribed to then there are available, a pro rata allotment will follow. This is also known as a scale back.

For example:

A shareholder holds a 2% stake in a company
The company issues 100,000 new shares
The shareholder will receive an amount of rights that would entitle to subscribe to 2,000 new shares (2% of 100,000).
In our example the shareholder exercises all his rights and subscribes to 2,000 new shares and gives instruction to oversubscribe to 1,000 new shares.
Let's say that after the event is finished, the agent establishes that 95% of the shares was subscribed to by normal means of exercising rights (this would leave 5,000 new shares available for oversubscription).
Let's say that the agent has received instructions to oversubscribe to an additional 10,000 shares.
The scaleback ratio on oversubscription in this case is 50% (5,000 / 10,000)
The shareholder in this example will receive and pay for 2,000 + 500 (oversubscription after scaleback) = 2,500 new shares.

In order to oversubscribe, the shareholder would not have to buy additional rights.

BUY

Rights themselves are securities that can be listed on a stock exchange (usually for a short period of time). Shareholders can go in the market and try to buy rights from shareholders who want to sell them.

SELL

Just like buying rights, a shareholder can also decide to sell his rights. He might want to do this because he might not have funds available to pay for any new shares from the event.

LAPSE

The investor might conclude that the rights offering is unattractive (out-of-the money for example) and instruct his broker or custodian to let the rights lapse. Rights can lapse worthless (they will be booked out as wortless after the event) or they can result in a (small) cash payment.

NOAC

Take No Action - this means that the investor is instructing their broker or custodian to leave the rights in their account and do nothing with them. An investor might hold accounts with several financial institutions and he could for example decide to transfer his rights to another custodian or broker.

CLAIMS FOR RIGHTS ISSUES (COMPENSATIONS):

DATES FOR TRADING

When trading securities in general, an investor needs to consider 3 dates:

Trade date

the date at which the securities change ownership

Contractual settlement date

the dates at which the securities need to be physically settled out of and into the safekeeping accounts of the trading partners and on which the money needs to be debited from the buyer and credited to the seller.

Actual settlement date

the date at which the trades actually get settled (should in theory be the same as contractual settlement date)

This means that there is a difference between purchasing the shares (and gaining ownership of them) and the date at which the shares acually fysically settle in their safekeeping account and the money is debited from their cash accounts. This phenomenon is also called a settlement cycle.

The most common forms of settlement cycles are:

T+2: The contractual settlement date is 2 days after the trade date

T+3: The contractual settlement date is 3 days after the trade date

DATES FOR RIGHTS ISSUES

When dealing with claims on rights issues, an investor needs to consider 2 dates: EXDATE and RECORD DATE.

The EXDATE is the date at which the shares are trading without the rights entitlements.

The RECORD DATE is used by the custodian to establish whom to pay the rights to.

Depending on the market (country) the dates will be set in different ways. There are two main principles:

Exdate driven markets

Record date driven markets

In Exdate driven markets, the exdate will be after the record date.

In Record date driven markets, the record date will be after the exdate.

When combining the settlement cycles with the different market principles there are several possible scenarios. Please see below the main ones.

In every example Trader A buys 100 shares from Trader B.

SCENARIO 1 Settlement cycle is T+3 and Market is RECORD DATE driven:

In this Scenario the Trader A buys the shares before the exdate of the rights issue event and will therefore be entitled to the rights. The shares will settle into his account on the RECORD DATE. The custodian will look at who has the shares at close of business on the RECORD DATE and will pay the rights one day later accordingly (in this case to trader A). There is no claiming involved.

SCENARIO 2 Settlement cycle is T+3 and Market is EXDATE driven:

In this Scenario trader A buys the shares before the EXDATE and will therefore be entitled to the rights. Trader B, however, will have the shares in his account at close of business of the RECORD DATE and the custodian will pay the rights to trader B on exdate. Once the trade on the parent line settles (in this scenario on EX+1), Trader A needs to claim the rights from Trader B. Trader B needs to deliver the rights to Trader A in the market.

SCENARIO 3 Settlement cycle is T+3 and Market is RECORD DATE driven - parent trade settles late

In this Scenario trader A buys the shares before the EXDATE and will therefore be entitled to the rights. Since the shares on the parent line are settling late, the shares will still be on trader B's account on record date and therefor the custodian will credit the rights to Trader B on record date+1. Trader A needs to claim the rights from Trader B.

Conclusion

Whenever shares are bought before exdate the buyer is entitled to receive the rights. Because of the time difference between buying and actual settlement, the rights are credited to the counterparty of the trade and hence the rights need to be transfered.

DEVELOPMENT OF THE SHAREPRICE

Please find below a description of the effects Rights Issue events can have on the share price in the market. For the calculations the following assumptions are used:

1) the investor holds 100,000 shares in company "ABC" before the rights issue event takes effect

2) the market price of the shares before the event = EUR 5.00

3) the nominal value of the shares before the event = EUR 1.00

Rights Issue (ratios: 1 right for every 1 share, 10 rights entitle to buy 1 new share for EUR 4.00)

In the example the sharehoder will receive 100,000 rights based on his holdings of 100,000 shares. With those 100,000 rights he is entitled to buy an additional 10,000 new shares at a subscription price of EUR 4 per share.

Value of his holdings before the rights issue: 100,000 x EUR 5.00 = EUR 500,000.

Value of his holdings after the rights issue:

100,000 x EUR 5.00 = EUR 500,000.

10,000 x EUR 4.00 = EUR 40,000

value of 110,000 shares: EUR 540,000

Theoretical market price after the exdate of the rights issue: EUR 540,000 / 110,000 = EUR 4.91 per share.

The theoretical value of every right equals therefore: EUR 5.00 - EUR 4.91 = EUR 0.09. In reality however, the right issue takes place over a period of time in which the value of the shares will change and hence the value of the rights will change accordingly.

Please note that every shareholder has got 4 basic option in a rights issue event:

1) Take No Action and let the rights lapse worhtless.

please note that under this option the value of his holdings decreases from EUR 500,000 to EUR 491,000. Put differently: he loses 100,000 x (EUR 5.00 - EUR 4.91) = EUR 9,000.

2) Sell the rights.

Under this option he will not lose any value if he manages to sell his rights for at least EUR 0.09 each.

3) Exercise the rights in order to subscribe to 10,000 new share for a total amount of EUR 40,000

In this case the value of his original holdings stays the same, however, he needs to invest an additional EUR 40,000 to achieve this.

4) buy (and subsequently exercise) additional rights from other shareholders. In this case the shareholder could make a profit if he manages to buy the rights for less than EUR 0.09 per right.

Combinations of the options mentioned above are possible as well.

The above are THEORETICAL calculations only. In reality, a rights issue will take place during the course of a couple of weeks and the share price is subject to several factors, like developments in underlying operations, macro-economic data and market sentiment. Also a shareholder needs to be confident that the management of the company will find good use for the extra money.

(Please note that any investment decicions made based on the content of this site are entirely at the reader's risk only. Please also note the disclaimer)

SETTING THE EXERCISE PRICE

The company is interested in raising as much money as possible and therefor in theory would like to set the exercise price as high as possible.

Shareholders and underwriters on the other hand will be interested in an exercie price that gives a substantial discount to the market. If the exercise price is too close to the market price of the securities, than investors have no real incentive to subscribe to new shares in the event (they can buy the same shares in the market for the same price).

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